Holman Jenkins

Nobody expects a Hollywood movie to be journalism, but “The Big Short,” the Hollywood movie about the 2008 financial crisis, partakes of journalism in one sense. It partakes of what might be called the universal journalistic bias, namely to exaggerate the importance of whatever is being reported.

Widely lauded for many virtues, especially comedic, the film nevertheless dwells mistakenly on an asset class that represented just 2% of bank assets and whose role in the global crisis has been grossly distorted. These highly rated securities were manufactured out of lower-rated, or subprime, mortgages. They got their triple-A rating because bond insurers and lower-rated security holders agreed to absorb the first losses. And, of course, even so, defaulted mortgages don’t become worthless—they default to the value of the repossessed house.

So how “toxic” were these securities? Well after the worst of the meltdown, Washington’s own Financial Crisis Inquiry Commission noted that “most of the triple-A tranches . . . have avoided actual losses in cash flow through 2010 and may avoid significant realized losses going forward.”

Or as this column pointed out at the very start of the subprime crisis in 2007, the “fluctuations in the S&P 500 wipe out as much wealth every ho-hum day.”

The “big shorts” paid millions to Goldman Sachs and others to concoct convoluted contracts that let them bet against these securities, and to find banks to take the opposing, or “long,” bet. (The irony being that, in this way, the movie heroes actually supported the manufacture of more subprime housing loans.) If they had really seen what was coming, our heroes would have saved themselves a lot of trouble and expense and simply shorted the big banks and the entire stock market—a bet that any day trader can make from the comfort of his bathrobe.

Far from being the lonely seers their fans imagine, the big shorts benefited from seeing the words “housing bubble” 425 times in The Wall Street Journal and the New York Times in the seven years leading to the crash. In 2004, the FBI warned of an “epidemic” of mortgage fraud.

Even John Paulson, the biggest short of all, according to later court testimony by a top deputy, didn’t foresee Armageddon, only that the “housing market had appreciated excessively and that housing prices would stabilize or flatten out or decline.”

The truth is a lot more interesting. The global crisis was a manufactured event—manufactured out of radical uncertainty about how government would treat the biggest banks, 2% of whose assets consisted of suddenly illiquid but not worthless mortgage securities. That may seem a mouthful, but Vince Reinhart, who had just retired as a top Fed official, stated matters plainly when he said the whole game had become “predicting government intentions.”

What’s more, this colossal snafu was telegraphed a long way off. Treasury Secretary Hank Paulson, in late 2007, had tried to round up private funding for a Super SIV (structured investment vehicle) to relieve banks of these securities and any accounting markdowns. Had he succeeded, or had the government simply waived its own rules to let banks hold these securities on their books at non-firesale values, the crisis would have been avoided.

Understand what we’re saying: The government saw early on how its regulatory machinery had become a trap for itself and the banks but couldn’t act fast enough, coherently enough, and apolitically enough to forestall unintended consequences. Yet at another level, as we’ve pointed out many times, confidence actually held up pretty well. Whatever the uncertain outcome for bank shareholders and wholesale creditors, the public showed strong faith that Washington, having learned from the 1930s, would uphold the solvency of the banking system for depositors.

Traditional bank runs didn’t happen. ATMs were not drained of cash by panicked withdrawals. The global panic was confined to large investors and the biggest bank customers who were not protected by formal deposit-insurance guarantees.

It was their withdrawal of confidence from the global financial system that caused the crash, that caused a sharp, unprecedented contraction of global trade, that caused a global economic panic that ultimately put the rich payday in the pockets of the “big short” protagonists. These protagonists were myopically focused on a narrow class of mortgage securities when being short just about anything would have afforded them an equally luscious accidental payday.

If you need an epilogue, look no further than this week’s junk-bond panic. Government (in this case, the Fed’s QE) again stimulated production of riskier assets for yield-hungry investors. At the same time, its bank capital and accounting regulations have again starved the market of liquidity to meet even a modest change in sentiment. Result: exaggerated volatility and losses for unwary investors.